Conclusions and recommendations
1. It is doubtful that this elaborate new
licensing regime for offshore electricity transmission will deliver
any savings for consumers.
The new regime involves the regulator choosing transmission providers.
This is more elaborate than alternative approaches, such as that
used in oil and gas where production companies make their own
arrangements for transmission, or using an existing onshore transmission
company such as National Grid. We have not seen convincing evidence
to show that there will be savings for consumers from this scheme
compared with potential alternatives. Indeed the new system could
well lead to higher prices for consumers. In applying the regime
for future licences, the Department and the Authority should:
- show clearly how the regime
is expected to produce better outcomes than alternative approaches;
and
- introduce a rigorous system of evaluation to
confirm whether projected savings are achieved.
2. There are fundamental weaknesses with the
model applied to the first licence competitions. The
terms of the licences awarded look too generous for the limited
risks investors are being asked to bear. The licences awarded
to date did not include any construction risk yet they provide
licensees with a guaranteed retail price index-linked income for
20 years regardless of the extent to which the assets are used.
At the same time operators can only be fined a maximum 10% of
their expected income in any one year if they fail to ensure their
facilities are available and working. Furthermore, investors are
not required to share any gains made from debt refinancing or
excessive equity profits. The Department and the Authority argued
that these terms were not overly generous as there was price competition,
but did not produce evidence to demonstrate that these are the
terms that offer the best prices for consumers. For future licences
and, where appropriate, licences already being competed, the Authority
should:
- require investors to provide
transparency over actual returns including those from sale proceeds,
and to share gains from debt refinancing and excess equity profits;
- reconsider whether a revenue stream linked to
the retail price index offers better value for money for consumers
than alternatives such as a flat or partially indexed revenue
stream;
- assess the benefits and risks of continuing with
guaranteed income for 20 year licence periods compared with shorter
licence periods or more regular price reviews within each licence
period; and
- consider higher penalties beyond the current
10% annual cap for failure to make assets available.
3. The licencing system relies on effective
competition to keep down prices for consumers but it is not clear
that a diverse and competitive market has been created.
The Department and the Authority are seeking to develop a competitive
market for offshore electricity transmission in contrast to the
onshore monopolies. But the first six licences have been won by
just two companies. The PFI market has also shown that even where
there is a diverse market initially, there may be consolidation
as the first investors sell to a smaller group of long-term investors.
The Authority should monitor the offshore transmission market
and should refer the market to the Competition Commission if consolidation
by a few companies undermines competition.
4. It is unacceptable that HM Treasury have
allowed the Department and the Authority to proceed with the new
regime without incorporating lessons from previous government
experience on PFI. Lessons learnt from
the PFI market, such as the sharing of refinancing gains, have
not been incorporated into the new offshore electricity transmission
market. HM Treasury's argument of not wanting to introduce any
limitations on investors is concerning given that it used a similar
argument with early PFI deals, only to reverse its position later.
HM Treasury should be alert to any part of government setting
up a new market, and make sure they learn from previous experience.
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